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6 tax & financial tips for the next lottery millionaire

UPDATE, Jan. 21, 2021: Congratulations to the owner of the $730.1 million winning Powerball ticket purchased in Western, Maryland. But there's still a chance for all us dreamers. The next Mega Millions jackpot on Friday, Jan. 22, will be at least $970 million — which would be the United States' third-largest lottery jackpot ever. 

Lottery vending machine
Picking lucky numbers from a lottery game dispenser.

More than $1 billion is up for grabs in the two nationwide lotteries. The Powerball jackpot is at $550 million. A solo Mega Millions winner will walk away with $600 million.

Since I know you've got your lotteries tickets in hand, here are six tax and financial tips in case you are the next big winner in either or both upcoming drawings.

1. Hire or at least consult a tax professional.
By now, everyone is well aware that lottery jackpots mean big winnings for the tax man, too, since Uncle Sam considers gambling proceeds (and other winnings) taxable income. A tax pro will be able to give you an overview of the myriad tax issues you'll face at the federal and your state and local levels.

Regardless of how you receive your winnings (more on this in tip #2), Uncle Sam will get his cut up front. At the federal level, taxes on lottery winnings of more than $5,000 are withheld automatically at the 24 percent rate.

If you happen to live a state with a personal income tax, which is most of them, you'll also likely owe your state tax collectors.

A few income-taxing states do have special tax rules for lottery winnings, ranging from lower rates to no taxes on resident winners.

Your tax adviser, and you should hire/consult him or her before you collect your winnings, can help you maneuver these immediate tax matters, as well as advise you on the next tax steps a sudden millionaire must consider.

Just make sure you (1) pick the type of tax preparer that best fits your new wealth needs and then (2) thoroughly check out that preparer to make sure that she or he is knowledgeable and trustworthy.

2. Decide how you want your money.
The smart-ass answer to the question as to when to collect your cash is "as soon as possible." But that's not necessarily the smart answer.

Depending on where you live, you'll have time, possibly months, to decide whether to get your winnings at once in a lump sum or as 30 annuity payments over 29 years (the first payment is immediate).

For the $550 million Powerball jackpot, the lump sum payment before taxes would be more than $411 million if you take a cash payout. The $600 million Mega Millions jackpot as one immediate payment is worth more than $442 million.

Your tax pro can help you break out the tax costs of the choices.

The advantage of taking a lump sum is you get all the money at once. The disadvantage of taking a lump sum is that you must pay tax on the entire amount in one tax year.

The advantage of an annuity is that you're taxed only as you receive the payments. The disadvantage of an annuity is you only get a few million a year. OK, not really a disadvantage, but you know what I mean.

You also don't have any control with an annuity over how the winnings might grow. Compare the effective yield of the annuity with what you could earn by taking the money at once, paying the taxes and then investing the proceeds on your own.

You also need to do a little economic and political prognosticating.

The current top federal individual ordinary income tax rate is, thanks to the Tax Cuts and Jobs Act (TCJA) enacted in late 2017 is 37 percent. Plus, if you do take the cash now and invest it, note that there's the added 3.8 percent net investment income tax that's tacked on to earnings by wealthy taxpayers, of which you'll be a part.

The current federal top individual tax is in effect through tax year 2025. But President-Elect Joe Biden will move into the Oval Office on Jan. 20 and he's been up-front about wanting to raise the top tax rate, as well as the capital gains tax on long-term investments. You never know if or when that will happen, but you need to be aware of the possibility.

That's a lot to consider, which brings us to tip #3.

3. Pick a team of financial and legal advisers.
Regardless of how you take the winnings, you're probably going to be in the highest tax bracket for a while. That tax professional you just hired will come in handy.

But all that moolah poses other financial considerations. You'll also want to add an investment adviser, accountant, insurance specialist and attorney to your new financial team. Each can help you sort through the financial and legal intricacies of dealing with such a large amount of money.

There are ways to legally shelter your income, but typically they are complex. That's why the rich hire the best and brightest advisers to maneuver through the financial and tax rules and regulations.

You are part of that wealthy club now, so use some of your winnings to hire experienced financial professionals to help safeguard your membership.

Leonardo DiCaprio as title character in 2013 movie The Great Gatsby_Warner Bros PR photo
Welcome to Club Wealthy!

4. Create short- and long-term wealth plans.
Now that you've got all the cash, make some plans so that you don't just blow through it. That happens way too often to sudden millionaires. Sure, a short-term goal might be to buy a new or better, not just bigger, house.

That's not necessarily a bad move. We all want a nice place to live in a good neighborhood and there still are some tax advantages to home ownership.

But you also need to think further into your new wealthy future. Again, this is where your group of gurus can help.

So that you stay in the top income tier, you'll want to create a wealth plan. This involves investments — remember, long-term capital gains are taxed, at least for now, at lower rates than ordinary income — and estate planning.

Don't forget about insurance. You'll have a lot more worldly goods that need to be protected. You'll also need coverage from the sadly inevitable lawsuits you could face from folks trying to cash in on your new-found wealth. And tying in with your estate plan, you should look into a policy that could provide some liquidity for your heirs if they need to pay any taxes on your estate.

5. Carefully consider gifts.
With all that new disposable income, you'll probably want to share the wealth. Good for you.

The gifts likely will include funds for charities, as well as to family and friends.

As for how the giving can help you, large charitable gifts to valid 501(c)(3) groups are still tax deductible if you itemize.

The TCJA increased how much you can give, up to 60 percent of adjusted gross income (AGI) from the prior 50 percent philanthropic limit. Even better, the Consolidated Appropriations Act, 2021, better known as the law enacted on Dec. 27, 2020, that also provided for the second round of COVID-19 economic relief payments, bumped that percentage threshold up to 100 percent for the 2021 tax year.

Now I'm not expecting or encouraging you to give away all your winnings. Just letting you know. It's just one of the things you'll need to consider.

Once you determine the size of your gift, don't just show up at your favorite IRS-approved nonprofit with a big check. Talk with the charity, and your tax and financial advisers, first. While the organization definitely will be grateful for the financial help, getting a huge gift also could pose some planning issues for the group. A well thought out giving plan can help not only the charities you choose, but also do a lot of good for your own financial and tax situations.

Again, your tax adviser can suggest options, such as establishing an endowment for your favorite nonprofit or a donor advised fund, that work best for your new tax and financial situation, as well as the charities with which you want to share your new wealth.

As for your family and friends, make sure you know what effect such a gift could have on them and you. True, gifts are never taxable to the recipient, but when you give more than the annual gift exclusion amount — which is $15,000 (again) this year — then you have some tax paperwork to complete.

Also, note that an extravagant gift, however well-intentioned, could have additional financial obligations that the recipient isn't prepared to meet.

An expensive car means higher auto insurance costs. A high-dollar home also will have more operating and maintenance costs, as well as an equally high property tax rate that the new homeowner might not be able to meet year after year.

And don't forget the ultimate gift, bequests to heirs. Again, your financial dream team can help you work through the considerations of what will happen to your money once you're gone.

The TCJA has greatly increased the federal estate tax exemption. Under the new inflation adjustments, heirs in 2021 can leave a tax-free estate of up to $11.7 million, twice that for a married couple. Unless legislative changes are made — again, keeping track of this is why you want a tax pro by your side — by your bequests are made even more (or less) of your estate could be free from the 40 percent (for now) federal estate tax.

Note that a handful of states also collect an estate tax. A couple have inheritance taxes, too, so include that possibility in your ultimate asset plans.

6. Add up your gambling losses.
OK, 2021 has just begun, so unless you have a major gambling problem, you probably don't have many gambling losses yet.

And realistically, if your numbers come up on the current Powerball and/or Mega Millions jackpots, you'll never accumulate enough in losing bets (again, unless you have a betting addiction) to make a dent in your taxes due on the winnings.

Old Powerball lottery tickets bought by SKB
Some of my old, losing Powerball tickets. Yes, I've been a sucker for big jackpots years!

But for the rest of us casual gamblers who occasionally drop a few dollars on lottery tickets or other games of chance, our meager winnings — my most recent lotto slip paid out a whopping $4 — might be offset by our more common gambling losses.

While the TCJA made a lot of changes to the Internal Revenue Code, one tax break of interest to bettors remains. You still can deduct your gambling losses against any winnings as an itemized deduction on Schedule A.

The key, as with all things tax, is to keep track of your gambling wins and losses throughout the year. Your losses can offset your winnings, but not create a gambling loss.

For most of who occasionally waste a few bucks on Powerball or Mega Millions when the pots get too big to resist, our lottery tickets will go into our gambling loss folder.

Tally all the numbers: I hope you one day are lucky enough to need to use these six tips. As I just mentioned and long-time readers of the ol' blog know, I spring for a lottery ticket or two when the jackpots are like these, so I hope I get to use them, too!

That's why today's By the Numbers figure is six, for the number of pieces of advice. (Quick note: I've yet to get the ol' blog switched over to the New Year, so there's no collected BtN 2021 page yet, but you can still check out last year's featured figures.)

I know, I could have gone with the huge jackpots or lump-sum payouts, either separately or combined.

But since the odds of hitting either lottery are very long for most of us, I'm going with the realistic number of 5 financial and tips.

And speaking of those odds, here are the specific numbers.

The chance of being the only Powerball big winner is 1 in 292 million. If you're hoping to be the lone Mega Millions millionaire, the odds are 1 in 302 million.

Finally, some numerical dates to add to the mix, just in case you don't know when the drawings will be.

Mega Millions money will be on the line again on Tuesday, Jan. 12. The Powerball lottery numbers will come up the next evening, Wednesday, Jan. 13.

Good luck to everyone, including me!

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